In a significant ruling for taxpayers engaged in the real estate sector and land aggregation business, the Karnataka High Court has held that advances received in the ordinary course of business cannot be treated as taxable income merely because they remain outstanding for several years. The Court clarified that unless there is clear evidence of forfeiture or the recipient becoming absolutely entitled to retain the money, such advances continue to remain liabilities and cannot be brought to tax.
The judgment came in Pr. Commissioner of Income Tax v. Shri Ravi Shankar Shetty (Income Tax Appeal No. 225 of 2021), where a Division Bench comprising Justice S.G. Pandit and Justice Rajesh Rai K dismissed the Income Tax Department’s appeal and upheld the decision of the Income Tax Appellate Tribunal (ITAT).
This decision provides valuable guidance on the tax treatment of business advances, the distinction between stock-in-trade and capital assets, and the concept of forfeiture under the Income-tax Act, 1961.
Background of the Case
The respondent-assessee, Shri Ravi Shankar Shetty, was engaged in the business of identifying, negotiating, and procuring land for real estate development projects. Under an agreement executed in 2006 with Metro Corp and Metro Corp Infrastructure Ltd., he received advances amounting to approximately ₹21.89 crore for procuring suitable parcels of land.
During the assessment proceedings, the Income Tax Department treated ₹21.11 crore out of the total advances as taxable income. According to the Department, since the advances had remained outstanding for nearly eight years and no demand for refund had been made by the companies, the amounts had effectively become the assessee’s income.
The Department argued that the prolonged retention of the advances indicated that the money had been forfeited, thereby making it liable to tax.
Assessee’s Stand
The assessee strongly disputed the addition and submitted that the advances were received strictly in the course of his regular business operations.
He argued that:
- The amounts represented business advances for procuring land.
- The transactions related to stock-in-trade and not capital assets.
- The advances had never been forfeited.
- The liability continued to exist in the books of account.
- There was no contractual or legal event that entitled him to permanently retain the money.
Therefore, according to the assessee, the advances could not be regarded as taxable income.
Revenue’s Argument
The Income Tax Department attempted to invoke the provisions relating to forfeiture of advances received during negotiations for transfer of capital assets.
According to the Department:
- Nearly eight years had elapsed without any refund.
- The absence of refund demonstrated that the advances stood forfeited.
- Consequently, the amount had become taxable in the hands of the assessee.
The Revenue therefore challenged the orders of both the Commissioner (Appeals) and the ITAT before the Karnataka High Court.
Karnataka High Court’s Findings
The High Court carefully examined the nature of the transactions and rejected the Revenue’s contentions.
The Court observed that the statutory provision relied upon by the Department applies only where:
- an advance is received during negotiations for transfer of a capital asset;
- the proposed transfer ultimately fails; and
- the advance is forfeited by the recipient.
The Court found that none of these essential conditions existed in the present case.
Instead, the advances had been received in the ordinary course of the assessee’s business of procuring land for real estate projects.
Stock-in-Trade Is Not a Capital Asset
One of the most significant observations made by the Court relates to the distinction between stock-in-trade and capital assets.
The Bench noted that the land proposed to be procured by the assessee formed part of his trading activities and therefore constituted stock-in-trade.
The Court observed that Section 2(14) of the Income-tax Act defines a “capital asset” but specifically excludes stock-in-trade from its ambit.
Accordingly, advances relating to transactions involving stock-in-trade cannot be equated with advances received towards the transfer of capital assets.
This distinction proved decisive in rejecting the Department’s arguments.
Mere Delay Does Not Mean Forfeiture
The High Court further clarified that mere passage of time cannot automatically convert an advance into taxable income.
The Court observed that simply because the advances remained outstanding for several years did not establish that they had been forfeited.
For an amount to become taxable on the ground of forfeiture, there must be clear evidence showing that:
- the liability has ceased; or
- the recipient has acquired an absolute right to retain the money.
In the present case, no such material was produced by the Department.
On the contrary, the advances continued to be reflected as outstanding liabilities in the assessee’s books of account.
Therefore, the liability had not ceased.
Reliance on Earlier Karnataka High Court Decision
The Court also relied upon its earlier judgment in CIT v. Alvares & Thomas, wherein it had held that mere lapse of time does not extinguish a liability.
Reaffirming that principle, the Bench observed that unless there is legal evidence demonstrating cessation of liability or forfeiture, outstanding advances cannot be treated as income merely because they remain unpaid for a long duration.
This precedent further strengthened the assessee’s case.
ITAT’s Decision Affirmed
The Income Tax Appellate Tribunal had earlier deleted the addition of ₹21.11 crore, holding that the advances retained their character as business liabilities.
The Karnataka High Court agreed with the Tribunal’s reasoning and found no legal infirmity in its conclusions.
Accordingly, the Revenue’s appeal was dismissed, and the Tribunal’s order was upheld in its entirety.
Practical Significance of the Judgment
The ruling has important implications for businesses, especially those engaged in:
- Real estate development;
- Land aggregation and procurement;
- Infrastructure projects;
- Construction and property consultancy; and
- Businesses receiving long-term contractual advances.
The judgment reinforces that accounting treatment and the true nature of a transaction are more important than the mere passage of time.
If an advance continues to be reflected as a liability and there is no evidence of forfeiture or cessation of obligation, it cannot be assessed as taxable income solely because it has remained outstanding for several years.
Key Takeaways
The Karnataka High Court has reaffirmed several important principles under the Income-tax Act:
- Business advances do not become taxable merely because they remain outstanding for a long period.
- Stock-in-trade is specifically excluded from the definition of “capital asset” under Section 2(14).
- Provisions relating to forfeiture of advances for transfer of capital assets cannot be applied to ordinary business transactions involving stock-in-trade.
- Mere delay or non-refund does not establish forfeiture.
- Unless the Revenue proves cessation of liability or the assessee’s absolute entitlement to retain the amount, outstanding business advances continue to remain liabilities and are not taxable as income.
Conclusion
The Karnataka High Court’s decision in Pr. Commissioner of Income Tax v. Shri Ravi Shankar Shetty serves as an important precedent for taxpayers dealing with long-standing business advances. The judgment reiterates that tax liability cannot be imposed merely on assumptions arising from the passage of time. Unless there is clear evidence of forfeiture, cessation of liability, or absolute ownership over the funds, advances received during the ordinary course of business retain their character as liabilities.
For businesses operating in the real estate and infrastructure sectors, this ruling offers significant clarity and reinforces the principle that taxation must be based on the true legal character of a transaction rather than presumptions or accounting timelines.